Each month, I meet with five to ten business owners that want to raise money for their startups. Since I’m the chair of a community angel investment fund, there are a lot of people that are told “go talk to Matt” when they ask around about raising capital to grow their business. I take as many of these meetings as I feasibly can, because I think it’s important for startup founders to know what sources of capital are and are not available to them. Too many startup founders end up taking bad fundraising deals that are not in their best interest, and I can help them avoid getting screwed by taking an hour and showing them what their options are, what’s realistic and what’s not. I once met a local business owner that had given up 90% of the equity in their company for less than $100,000 in startup capital.
When bad deals take place it is often because startup founders haven’t taken the time to educate themselves about what their company might be worth, how much capital their company needs and what sources of capital are available to them. There also aren’t many great resources about how to raise money outside of a startup hub such as San Francisco or Boulder, which makes it difficult for them to educate themselves even if they wanted to. Finally, shows like The Profit and Shark Tank provide an overly-simplistic presentation of the venture capital process and don’t show the months-long process of due-diligence and deal-negotiation. The confluence of these issues often leads startup founders to have unrealistic expectations and misconceptions about how the venture capital process works.
Here are some common misconceptions that startup founders have about raising money:
- “If the investor likes my business, she or he will write me a check tomorrow.” One applicant to Falls Angel Fund thought they were going to get a check on the same day as their initial pitch. The reality is that the gears of venture capital turn very slowly. It takes several months of discussion, deal negotiation, and due diligence to make a deal happen. If you tell me you need money by next month, I likely won’t be able to help you because of the constraints of the angel fund’s every-other-month meeting structure. If you think you are going to need money for your business six months from now, you should start having discussions with investors today because it really does take that long.
- “My company is worth $10 million today because it has massive potential.” In my history of angel investing, only one company has proposed a valuation that was too low for the progress they had made. Most startup founders think their companies are worth far more than they are. One applicant to Falls Angel Fund asked for a $10 million+ valuation, despite having no revenue, no traction and no customers. You need to be realistic about how much your company is worth and set a valuation that allows both you and the investor to make a healthy return and accurately reflects the business progress that you have made today (not the business progress you assume you are going to make over the next three years).
- “I only need a really good idea and a great pitch to get my company funded.” Private equity investors take into consideration many different factors when deciding to do a deal, such as market opportunity, business valuation, track record of the entrepreneur, the quality of the business plan, the business’s current traction, the location of the business and the industry the business is in. You might have the best idea in the world, but you also need to prove that you are the person capable of executing on that idea and building a business around it. You do this by demonstrating a track record of success, showing you are knowledgeable about your industry, having a strong moral character, being well-respected in the community, and showing early traction in your business.
- “My business is a can’t lose opportunity. You’d be crazy not to invest.” One startup founder told me that they had accounted for every possible risk in their deal and there was no way that I could lose money by investing with them. The only investment that has no risk, at least theoretically, are U.S. Treasury bonds, and they only pay a 3% yield. No matter how much of a sure thing you think your deal is, there are inherent risks in your business deal. You could get hit by a truck tomorrow. A supplier or a vendor could screw you. Another competitor could outcompete you and take away your customers. If your deal truly was risk-free, you would just max out your credit cards and get a second mortgage on your home to pay for the deal.
- “One investor or investment group can provide me all of the capital I need.” One founder recently asked me if Falls Angel Fund would invest $1 million into his company. For one, I can’t even make investment decisions on behalf of Falls Angel Fund. It is a member-managed fund and requires a majority vote to do any deal. Second, Falls Angel Fund has a capitalization of $1.4 million which means we can realistically only invest between $50,000 and $150,000 in each portfolio company or we won’t be diversified enough. If you need to raise $1 million for your company, it will more than likely come from a variety of different investors working collaboratively to fund your company. You will need one lead investor that will invest between 30% and 70% of your investment round as well as several smaller investors to fill out the remaining allocation.
Wrap-up
If you think you are going to raise money for your business at any point in the future, learn everything you can about how venture capital works. Read Brad Feld’s Venture Deals and Jason Calacanis’ book Angel. Meet with local angel investors and not-for-profit service providers like Enterprise Institute and the Small Business Development Center. Learn the terminology used in venture capital. Meet with founders that have successfully raised money. Give yourself an education on venture capital, so that you can negotiate a deal that’s in your best interest and so that you have a clear understanding of how the process works before pitching investors.